Ask the expert: When should I pay to switch out of a CD?
August 08, 2011
Q: If I lock into a long-term CD and interest rates rise, how do I know at what point it's worth "breaking" the CD - paying the penalty to get out earlier so I can get a new CD at the higher interest rate?
A: Most CDs do carry a penalty for early termination. So when is it worth paying that penalty so you can roll over into a CD at a higher interest rate? The time to start thinking about it is when the extra interest you could earn on a new CD exceeds the penalty you would pay. Remember, this is a function of both the incremental interest rate on a new CD and the time remaining on your old CD, compared to the penalty on the old CD.
When it would be worth more to switch than to stay in your current CD, you should be thinking about early termination, but that's not necessarily the time to act. You'll want to get a sense of what kind of momentum seems to be behind CD rates. If they are rising rapidly, you might want to hold off to see if you could do even better in a month or two. Also, there is the value of your time. You won't want to switch for every minor incremental edge you could get with a new CD, but it is worth doing when those differences become significant. Translating those differences from theoretical interest rates to projected dollars should help you put this decision into perspective.
Of course, this is a reminder of the fact that there is more to choosing a CD than just finding the best CD rates. Seeking to minimize the termination penalty is also an important consideration. After all, a shift in the interest rate environment could easily leave today's best CD rates far behind.
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